1. The European Union is primarily intended to permit:
a. Countries to adopt scientific tariffs on imports
b. An agricultural commodity cartel within the group
c. The adoption of export tariffs for revenue purposes
d. Free movement of resources and products among member nations

2. Which of the following represents the stage where economic integration is most complete?
a. Economic union
b. Customs union
c. Monetary union
d. Common market

3. Which of the following represents the stage where economic integration is least complete?
a. Free trade area
b. Monetary union
c. Common market
d. Customs union

8. Which trade instrument has the European Union used to insulate its producers and consumers of agricultural goods from the impact of changing demand and supply conditions in the rest of the world?
a. Domestic content regulations
b. Variable import levies
c. Voluntary export quotas
d. Orderly marketing agreements

9. Assume that the formation of a customs union turns out to include the lowest-cost world producer of the product in question. Which effect could not occur for the participating countries?
a. Trade creation-production effect
b. Trade creation-consumption effect
c. Trade diversion
d. Scale economies and competition

10. Which organization of nations permits free trade among its members in industrial goods, while each member maintains freedom in its trade policies toward non-member countries?
a. European Union
b. Benelux
c. Council for Mutual Economic Assistance
d. North American Free Trade Association

11. Which of the following organizations is considered a regional trading arrangement?
a. Organization of Petroleum Exporting Countries
b. North Atlantic Treaty Organization
c. Benelux
d. International Tin Agreement

12. When products from high-cost suppliers within a customs union replace imports from a low-cost nation that is not a member of the customs union, there exist(s):
a. Dynamic welfare losses
b. Dynamic welfare gains
c. Trade creation
d. Trade diversion

13. Which form of economic integration occurs when participating countries abolish tariffs on trade among themselves, establish a common tariff on imports from nonmembers, and permit free movement of capital and labor within the organization?
a. Free trade area
b. Economic union
c. Common market
d. Monetary union

15. A dynamic welfare gain resulting from the formation of the European Union would be:
a. Trade diversion
b. Trade creation
c. Diseconomies of scale
d. Economies of scale

16. Which organization was founded in 1957 whose objective was to create an economic union among its members?
a. General Agreements on Tariffs and Trade
b. Organization of Economic Cooperation and Development
c. European Union
d. Latin American Free Trade Association

18. Which nation is not a member of the North American Free Trade Association?
a. Canada
b. Greenland
c. Mexico
d. United States

19. Suppose a communist country agrees to pay for delivery of machinery with goods produced by the machinery. This arrangement refers to:
a. Countertrade
b. International commodity agreements
c. Coproduction agreements
d. Trade diversion

21. Under the European Union’s common agricultural policy, a variable import levy equals the:
a. Amount by which the EU’s support price exceeds the world price
b. Amount by which the world price exceeds the EU’s support price
c. Support price of the EU
d. World price

22. Members of the European Union find that “trade creation” is fostered when their economies are:
a. Highly competitive
b. Highly noncompetitive
c. Small in economic importance
d. Geographically distant

23. The European Union has achieved all of the following except:
a. Adopted a common fiscal policy for member nations
b. Established a common system of agricultural price supports
c. Disbanded all tariffs among its member countries
d. Levied common tariffs on products imported from nonmembers

24. When the United States, Canada, and Mexico form a free trade area, and Mexico begins importing a product from Canada rather than from the lowest cost world producer.
a. Trade diversion occurs
b. Trade creation occurs
c. World welfare rises
d. World welfare falls to zero

25. When the formation of a free trade area results in the reduction of trade with nonmember nations in favor of member countries, ____ occurs.
a. Trade devaluation
b. Trade revaluation
c. Trade destruction
d. Trade diversion

26. Which country is not a member of the European Union?
a. Spain
b. Germany
c. France
d. Iceland

27. The implementation of the European Union has:
a. Made it harder for Americans to compete against the Germans in the British market
b. Made it easier for Americans to compete against the Germans in the British market
c. Made it harder for Americans to compete against the Japanese in the British market
d. Made it easier for Americans to compete against the Japanese in the British market

28. The common agricultural policy of the European Union has:
a. Increased American farm exports to the EU
b. Decreased American farm exports to the EU
c. Lowered the price of American farm exports to the EU
d. Not affected the price of American farm exports to the EU

29. The implementation of a common market involves all of the following except:
a. Elimination of trade restrictions among member countries
b. A common tax system and monetary union
c. Prohibition of restrictions on factor movements
d. A common tariff levied in imports from nonmembers

Figure 8.1 depicts the supply and demand schedules of calculators for Greece, a “small” country that is unable to affect the world price. Greece’s supply and demand schedules of calculators are respectively depicted by SG and DG. Assume that Greece imports calculators from either Germany or France. Suppose Germany is the world’s low-cost producer who can supply calculators to Greece at $20 per unit, while France can supply calculators at $30 per unit.

43. At the Maastricht Summit of 1991, European Union negotiators called for the pursuit of a:
a. Free trade area
b. Customs union
c. Common market
d. Monetary union

44. By removing discriminatory government procurement laws within the European Union, member nations hoped to benefit from all of the following except:
a. EU governments could purchase from the cheapest foreign suppliers
b. Increased competition occurs as domestic firms compete with foreign firms previously shut out of the domestic market
c. Industries are restructured which permits surviving firms to achieve economies of scale
d. Agricultural prices fall as more farmers are allowed to produce their commodities

45. Suppose that government procurement liberalization results in the U.K. government importing automobiles from Germany, the low-cost EU manufacturer. Cost savings could result from all of the following except:
a. Competition effect
b. Scale-economy effect
c. Protective effect
d. Trade effect

46. Suppose that steel from Japan faces a 20 percent tariff in France and a 25 percent tariff in Italy, while France and Italy maintain free trade between each other. France and Italy are therefore part of a (an):
a. Free trade area
b. Customs union
c. Common market
d. Economic union

47. Suppose that Mexico and Canada form a free-trade area and Canada begins importing steel from Mexico rather than from Germany. There occurs:
a. Trade diversion
b. Trade creation
c. Trade destruction
d. Trade exhaustion

48. Suppose that Mexico and Canada form a free-trade area. Mexicans then decrease auto manufacturing and increase imports of autos from Canada, while the Canadians decrease computer production and import more computers from Mexico. This is an example of:
a. Trade diversion
b. Trade creation
c. Trade destruction
d. Trade exhaustion

49. If the United States and Canada abolish all tariffs on each other’s goods and implement a common tariff on goods imported from other countries, there occurs a (an):
a. Free-trade area
b. Customs union
c. Common market
d. Economic union

50. Suppose that the United Kingdom and Italy abolish all tariffs on each other’s goods and all restrictions on movements of factors of production between them. They also implement a common protectionist policy toward other countries. This is an example of a (an):
a. Free-trade area
b. Customs union
c. Common market
d. Economic union

51. The North American Free Trade Agreement was expected to benefit ____ the most.
a. Canada
b. Mexico
c. Greenland
d. United States

53. In the United States, which group was most likely to be hurt by the North American Free Trade Agreement?
a. Unskilled labor
b. Skilled labor
c. Owners of capital equipment
d. Owners of financial capital

55. When Mexico became a part of NAFTA, along with Canada and the United States, it:
a. Eliminated tariffs against Canada and the United States but maintained them against nonmembers
b. Eliminated tariffs against Canada, the United States, and all nonmember countries
c. Increased tariffs against Canada the United States, and all nonmember countries
d. Increased tariffs against Canada and the United States, but did not change them against nonmember countries

56. In a centrally-planned economy:
a. Commercial decisions are made by independent buyers and sellers acting in their own interest
b. Market-determined prices are used for allocating scarce resources
c. Prices play a rationing role so that the availability of goods is made consistent with buyer preferences and income
d. Government controls prices and output of goods bought and sold, with minimal recognition given to considerations of efficiency

57. The failure of the centrally-planned economies was exemplified by all of the following except:
a. Interest rates that were below free-market levels
b. Consumer and producer goods of inferior quality
c. Declining rates of economic growth
d. Shortages of essential goods and services

58. The transition of the former communist countries to market economies requires:
a. Implementation of governmental price controls
b. Privatization of public property
c. Transforming competitive industries into monopolies
d. The sale of private industries to the government

59. The transition of the former communist countries to market economies would likely result in:
a. The implementation of price ceilings
b. The implementation of price floors
c. Price inflation
d. Price deflation

60. In the former Soviet Union, major manufacturing firms were typically:
a. Owned and operated by employee labor unions
b. Owned and operated by the government
c. Privately owned, but operated by the government
d. Publically owned, but operated by the private sector

61. The transition of the former communist countries to market economies requires all of the following except:
a. Removing domestic price controls
b. Opening economies to international competition
c. Establishing private property rights
d. Terminating the convertibility of their currencies

62. The former communist countries included all of the following except:
a. East Germany
b. Soviet Union
c. Austria
d. Poland

63. The regional trade block of the former communist countries, which lasted from 1949-1991, was known as the:
a. Eastern European Economic Area
b. Nordic Preferential Trade Agreement
c. Council for Mutual Economic Assistance
d. European Industrial Cooperation Union

64. The economic reforms of the early 1990s that occurred in the former Soviet Union and Eastern Europe resulted in:
a. The formation of the Council for Mutual Economic Assistance
b. Multinational firms refusing to operate in these nations
c. A movement from centrally-planned economies toward market economies
d. A movement from market economies toward centrally-planned economies

65. The transition from government-controlled prices to market-determined prices in the former communist countries would be expected to result in:
a. Price stability
b. Price deflation
c. Price inflation
d. None of the above

66. Suppose that Canada has domestic firms that could supply its entire market for radios at a price of $50, while U.S. firms could supply radios at $40 and Mexico at $30. Suppose that Canada initially has a 50 percent tariff on imports of radios and then forms a free trade area with the United States. As a result, Canada realizes:
a. Trade creation, no trade diversion, and overall welfare gains
b. Trade creation, no trade diversion, and overall welfare losses
c. Trade diversion, no trade creation, and potential overall welfare losses
d. Trade diversion, trade creation, and potential overall welfare gains

67. Suppose that Canada has domestic firms that could supply its entire market for radios at a price of $50, while U.S. firms could supply radios at $40 and Mexico at $30. Suppose that Canada initially has a 50 percent tariff on imports of radios and then forms a free trade area with Mexico. As a result, Canada realizes:
a. Trade creation, no trade diversion, and overall welfare gains
b. Trade creation, no trade diversion, and overall welfare losses
c. Trade diversion, no trade creation, and potential overall welfare losses
d. Trade diversion, trade creation, and potential overall welfare gains

68. As of 2002, members of the European Monetary Union agreed to replace their currencies with the:
a. mark
b. dollar
c. franc
d. euro

69. The formation of the European Monetary Union is expected to entail benefits for member countries which include all of the following except:
a. Greater certainty for investors within the EMU
b. Lower costs of transactions within the EMU
c. Independent monetary policies run by the central bank of each member country
d. Enhanced competition among companies in member countries

70. According to the theory of optimum currency areas, a currency area has the least chance for success when:
a. Countries of the currency area have differing business cycles
b. Workers have a high degree of mobility across borders of the currency area
c. Prices and wages can be adjusted in response to economic disturbances
d. A single monetary policy affects all member countries in the same manner

71. A main disadvantage of the European Monetary Union is that:
a. Each member country loses the use of monetary policy as to tool to combat recession
b. There is a high degree of labor mobility among the member countries
c. Prices are highly flexible in response to changing economic conditions
d. Wages are highly flexible in response to changing economic conditions

72. World welfare under a customs union
a. Increases due to a trade creation effect
b. Decreases due to a trade diversion effect
c. Depends on the relative strength of the trade creation effect and the trade diversion effect
d. All of the above

73. A common market
a. Allows the imposition of common external trade barriers against non-members
b. Represents less economic integration than a free trade area
c. Does not permit free movement of goods among member nations
d. Does not allow free movement of factors of production among nations

75. For decades, the Eastern European countries have suffered from
a. Widespread price controls
b. Excessive competition
c. Lack of enforceable property rights
d. Both a and c

TRUE/FALSE

The figure below depicts the steel market for Portugal, a small nation that is unable to affect the world price. Assume that Germany and France can supply steel to Portugal at a price of $200 and $300 respectively.

Figure 8.2. Portugal’s Steel Market

1. Consider Figure 8.2. With free trade, Portugal will import 25 tons of steel from Germany at a price of $200 per ton.

6. Consider Figure 8.2. As a result of a customs union formed with France, Portugal’s overall welfare rises by $900.

7. Consider Figure 8.2. If Portugal had formed a customs union with Germany, Portugal’s welfare would have decreased by $500.

8. The European Union protects its agricultural producers from import competition by the use of tariff rates that vary directly with world prices.

9. Under the variable levy system of the European Union, EU farmers are protected against import competition by tariffs that vary inversely with the world price.

10. Trade creation tends to more than offset trade diversion for a home country forming a customs union with partner countries when: (1) the tariff rate in the home country is high prior to the formation of the customs union; (2) there are a large number of countries forming the customs union.

11. If Chile and Mexico form a free-trade agreement, the welfare of the two countries will necessarily increase.

12. If Chile and Mexico abolish all tariffs on each other’s products while maintaining their own tariffs against other countries, these two countries have formed a customs union.

13. With a preferential trading arrangement, a group of countries agrees to unilaterally reduce tariffs applied to imports from all countries of the world.

14. Economic integration is the process of eliminating restrictions on international trade, payments, and factor mobility.

15. When a group of countries establish a free-trade area, they achieve the highest stage of economic integration.

16. A free-trade area is an association of trading countries whose members agree to remove all trade restrictions among themselves, while each member country imposes identical trade restrictions against nonmember countries.

17. If the United Kingdom and Italy eliminate all tariffs on each other’s goods and all restrictions to factor movements between them, and implement a uniform system of import restrictions against the rest of the world, these countries have formed a common market.

18. The highest stage of economic integration is a monetary union.

19. Trade creation would occur if Canada and the United States form a free-trade area, and Canadians then import less steel from the United States while importing more steel from Japan.

20. Suppose that Mexico and Canada form a free-trade area. The Mexicans then decrease refrigerator manufacturing and increase imports of refrigerators from Canada, while the Canadians decrease auto manufacturing and import more autos from Mexico. This is an example of trade creation.

21. Trade creation and trade diversion refer to the short run (static) effects of economic integration while economies of scale, stimulus to investment, and effects on competition refer to the long run (dynamic) effects.

22. For countries forming a customs union, the trade-creation effect represents a welfare loss and the trade-diversion effect represents a welfare gain.

23. In the short run, Mexico would realize overall welfare gains from becoming a member of the North American Free Trade Agreement if the resulting diseconomies of scale effect more than offset the competition effect.

24. Trade creation occurs when imports from a low-cost supplier outside of a customs union are replaced by purchases from a higher-cost supplier within the union.

25. If a customs union includes the low-cost supplier of the world, there would be no adverse trade-diversion effect that would counteract the positive trade-creation effect.

26. The potential for trade diversion is smaller when a custom union’s external tariff is lower rather than higher.

27. If a customs union included all of the countries in the world, there could exist only trade creation, not trade diversion.

28. The larger the size and the greater the number of countries in a customs union, the greater will be the trade-diversion effect.

29. Over the long run, the formation of a customs union may yield welfare gains due to economies of scale, greater competition, and stimulus to investment.

30. By the mid-1990s, the European Union had essentially achieved the common market stage of economic integration.

31. At the Maastricht Summit of 1991, members of the European Union expressed the goal of achieving the common market stage of economic integration.

32. To protect its farmers from foreign competition, the European Union has utilized variable import levies and export subsidies.

33. To protect its farmers from imports of agricultural goods, the European Union has implemented tariff rates that vary directly with world prices.

34. As of 1992, the European Union had achieved the monetary union stage of economic integration.

35. The Maastricht Treaty of 1991 established a blueprint for economic union and monetary union for European Union members.

36. It is generally agreed that completing the common market stage of integration for the European Union contributed to overall welfare losses due to trade diversion exceeding trade creation.

37. Government procurement liberalization permits a country to realize cost savings resulting from the trade effect, competition effect, and economies-of-scale effect.

38. During the 1980s and 1990s, the United States negotiated free-trade agreements with Israel, Mexico, and Canada.

39. Forming a free-trade agreement with the United States provided Canadian producers a danger and an opportunity. The danger was that U.S. producers might be more price competitive than Canadian producers; the opportunity was that longer production runs for Canadian producers, made possible by a free-trade agreement, would result in cost reductions due to economies of scale.

40. Some trade creation was expected to occur as a result of the U.S.-Canada free-trade agreement, since Canadian exports to the United States and U.S. exports to Canada were expected to expand at the expense of imports from Germany and Japan that faced trade restrictions.

41. Negotiating the North American Free Trade Agreement was relatively easy since it involved meshing two large industrial countries with a developing country.

42. Critics of the North American Free Trade Agreement maintained that it would result in manufacturing firms fleeing Mexico’s stringent pollution-control policies and relocating in the United States and Canada.

43. U.S. labor unions argued against the North American Free Trade Agreement on the grounds that it would result in U.S. companies relocating in Mexico in order to take advantage of lower wage rates.

44. The North American Free Trade Agreement was expected to provide proportionately smaller benefits to Mexico than to the United States or Canada.

45. In the former Soviet Union, production of capital goods was determined by the free market while consumer-goods production was determined by central planning.

46. The former Soviet Union was characterized by central economic planning and public ownership of manufacturing enterprises.

47. Pricing of consumer goods in the former Soviet Union was typically regulated by price ceilings which led to shortages.

48. The transition of the former Soviet Union from a planned economy to a market economy would require the elimination of price controls, the privatization of public property, and the promotion of business competition.

49. From the 1940s to the 1980s, the former communist countries remained isolated from the world economy, primarily due to different tariff systems among the former communist countries.

50. A political dilemma facing the former communist countries in the 1990s was that the transition from a centrally-planned economy to a market economy would result in short-run costs but long-run benefits.

SHORT ANSWER

1. What is meant by economic integration?

2. What factors influence the extent of trade creation and trade diversion?

ESSAY

1. Explain the theory of optimum currency areas.

2. Concerning transition economies, what do the advocates of shock therapy propose?